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High-yield Connect ready for growth

Specialist distributor Connect Group has announced some major strategic progress in its attempts to diversify into growth markets, but the valuation remains low and the dividend yield high.
November 20, 2014

Connect Group's (CNCT) lowly valuation reflects concerns about the long-term decline of its traditional business, Smiths News, which serves the dwindling newspaper and magazine market. However, we believe a share rating of less than nine times forecast earnings overlooks the work that has been done to diversify the business into potentially exciting growth areas. What's more, Connect boasts solid cashflows that look very capable of supporting the shares' attractive yield.

 

Since changing the name of the company from Smiths News to Connect Group in April - reflecting the company's aim to deliver half of profits outside its flagship Smiths News and magazine distribution service - management has been successfully plugging holes in its existing operation while scouring the market for the next big thing.

The process began in October with news of two new ventures in parcels and coffee, which will utilise Connect’s existing route network, which means little start-up capital should be required to expand into these growth markets. The first venture announced was Pass My Parcel, a click-and-collect delivery service enabling Amazon shoppers to pick up orders from their local newsagent within hours of making an order. By tapping into Smiths News' distribution network and half-empty vans, entrance into this market, which analysts at JPMorgan Cazenove predict will more than double in size between 2014 and 2017, should be relatively straightforward.

The same is true of Connect’s other recent initiative, Jack Bean, which involves supplying coffee, and the machines that make it, to the same convenience stores across the country that it has been distributing newspapers and mags to for years. Given the nation’s love of coffee, this too could turn into a very profitable operation.

The icing on the cake has come with the acquisitions of Tuffnells Parcels Express this month. The business, a next day B2B deliverer of parcels of irregular dimension and weight, is being acquired for £113m, using a £55m rights issue at 102p and extended debt facilities. The acquisitions is expected to be earnings enhancing in year one and substantially earnings enhancing in year three. In effect, Tuffnells supplements the Pass My Parcel and Jack Beans ventures by providing Connect with a market-leading business with national coverage.

These new initiatives should eventually help offset the challenges faced by its other division. The books division has been hit by margin erosion as business moves online. But management plans to give books the same cost-cutting treatment that helped Smiths News reinvigorate itself. Action taken to improve the performance of the division saw profits rise 7 per cent last year and long-term distribution contracts means 84 per cent of its revenue is secure to 2019. Meanwhile, Connect's Education and Care division traded well last year with underlying profits rising 5 per cent.

The steady revenue stream from newspaper and magazine distribution should help support Connect’s reputation as a strong generator of cash, which should not only fund the expansion of new initiatives but also underpin a rising dividend - the board recently proposed a dividend per share of 9.7p, representing a yield of nearly 6 per cent.

IC TIP: Buy at 166p
Tip style
Value
Risk rating
Medium
Timescale
Long Term
Bull points
  • Diversifying into new growth areas
  • New acquisition brings national coverage
  • Cost-cutting measures working well
  • Fat sustainable dividend yield
Bear points
  • News market in long-term decline
  • Books business struggling

CONNECT GROUP (CNCT)
ORD PRICE:166pMARKET VALUE:£315m
TOUCH:164p-170p12-M HIGH:248pLOW: 135p
FORWARD DIVIDEND YIELD:6.3%FORWARD PE RATIO:9
NET ASSET VALUE:*NET DEBT:£93m

Year to 31 AugTurnover (£bn)Pre-tax profit (£m)**Earnings per share (p)**Dividend per share (p)
20121.8047.515.28.60
20131.8149.915.79.30
20141.8150.018.69.70
2015**1.7748.617.210.1
2016**1.7350.519.410.5
% change-2+4+13+4

Normal market size:1,500

Matched bargain trading

Beta:1.0

*Negative shareholder funds

**JPMorgan Cazenove forecasts, adjusted PTP figures